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Auditing

The
SEC approved PCAOB Auditing Standard No. 16, Communications With
Audit Committees, and related amendments to PCAOB standards
that were designed to help external auditors communicate effectively
with audit committees during public company audits.

All U.S. public companies, including emerging growth companies as
defined in the Jumpstart Our Business Startups (JOBS) Act, P.L.
112-106, will be required to comply with the standard.

The standard is designed to facilitate effective two-way
communication, and is aimed at external auditors because the PCAOB has
no authority over audit committees. It requires auditors to:

Establish the terms of the audit engagement with the audit
committee and record them in an engagement letter.

Give audit committees an overview of the audit strategy, including
the timing of the audit, significant risks identified, and
significant changes to the planned audit strategy or risks.

Reveal the identities of others involved with the audit, including
internal auditors or other independent auditing firms.

Give an evaluation of the quality of the company’s financial
reporting, including conclusions about critical accounting estimates
and the company’s financial statement presentation; difficult or
contentious matters for which the auditor consulted outside the
engagement team; the auditor’s evaluation of the company’s ability
to continue as a going concern; and difficulties encountered in
performing the audit.

The standard, available at tinyurl.com/ate8vy6, is
effective for audits of financial statements with fiscal years
beginning on or after Dec. 15, 2012.

Center for Audit Quality (CAQ) Executive Director Cindy Fornelli
said in a comment letter, available at tinyurl.com/a5antxm, that the
standard will contribute to investor protection because it should
improve audit quality and audit committees’ oversight. The CAQ is
affiliated with the AICPA.

Insufficient testing of controls and failure to properly evaluate
control deficiencies were among the common findings that led the PCAOB
to issue a summary of observations from 2010 inspections of audits of
internal control over financial reporting (ICFR).

The PCAOB released a 31-page report on deficiencies in firms’ audits
of ICFR. The report, available at tinyurl.com/auywqhf, does not
identify individual audits, but includes information summarized from inspections.

Deficiencies found under PCAOB Auditing Standard No. 5, An Audit
of Internal Control Over Financial Reporting That Is Integrated With
an Audit of Financial Statements, were included in the report,
which was issued to help inform auditors on common problems to avoid.

In 46 of the 309 audit engagements inspected by the PCAOB in 2010
that were referenced in the report, the PCAOB found that the firm had
failed to obtain enough evidence to support its audit opinion on the
effectiveness of internal control.

In an additional 50 of the 309 audit inspections, the PCAOB found
what it considered to be deficiencies in firms’ quality-control
systems that required remediation. Those deficiencies did not mean the
audited companies had materially misstated financial statements or had
inadequate internal controls. Rather, the deficiencies generally
indicated failure by engagement teams to comply with their firms’
methodologies, according to the report.

The most commonly identified deficiencies named in the report were
firms’ failures to:

Identify and test controls that are intended to address the
risks of material misstatement.

Sufficiently test the design and operating effectiveness of
management review controls that are used to monitor the results of
operations, such as:

Monthly comparisons of budget and
actual results to forecasts for revenues and expenses.

Comparisons of other metrics, such as profit margins and
certain expenses as a percentage of sales.

Quarterly balance sheet reviews.

Obtain sufficient evidence to update the results of testing of
controls from an interim date to the company’s year end (the
roll-forward period).

Sufficiently test the system-generated data and reports that
support important controls.

Sufficiently perform procedures regarding the use of the work of
others.

Sufficiently evaluate identified control deficiencies and consider
their effect on both the financial statement audit and the audit of
internal control.

“We encourage all auditors to … consider the items noted in
planning and performing public company audits,” the CAQ’s Fornelli
said in a statement. “We also encourage preparers and audit committee
members to familiarize themselves with the report as it may contain
observations that might be useful in improving upon the design or
operating effectiveness of internal controls over financial reporting.”